Oct 16, 2023

What is a Mortgage Loan Buydown and How Might it Save Me Money?

In today’s mortgage landscape, there are plenty of tools to help hopeful homebuyers. 

You could explore a VA loan (if you qualify) to score a home loan with zero down and minimal closing costs. 

You could work with a mortgage broker to shop around for the very best deal. 

You could even see if a mortgage loan buydown (“buydown”) could help you save. 

But what is a buydown? You probably haven’t heard this term much, but it’s a strategy that all homebuyers should at least be aware of. 

Let’s dive into the definition, how buydowns work, and, most importantly, how you might benefit as a borrower. 

What is a Mortgage Loan Buydown? 

Buydown:</strong> A financial arrangement where the borrower or a third party (think the home seller or builder) agrees to pay the lender additional cash at closing to “buydown the interest rate”. In exchange, the lender drops the borrower’s interest rate for a set period. Buydowns typically last only a few months or a few years but, in some cases, can be permanent. 

The goal here is to make the mortgage loan payments more affordable by reducing the interest rate. The borrower might pay for the buydown to lock in lower monthly interest payments. The seller or builder might pay for the buydown to make the deal more enticing. 

How Can a Buydown Save Me Money? 

To really understand how a buydown works, we first need to review the structure of a mortgage loan payment. That’s because a buydown could save you money by reducing your interest rate. Basically, you’ll pay less interest and therefore a smaller interest portion of your monthly mortgage loan payment to save more money over time and to reduce your total monthly payment for each month the buydown is in effect. 

Principal: The original loan amount. Say you’re purchasing a $300,000 home with $50,000 down. You’ll borrow the other $250,000 from a mortgage lender, and that amount becomes your principal. 

Interest: A fee you pay in exchange for the privilege of borrowing money. Basically, the lender charges you a percentage amount, say 8%, to use their money. You end up paying dramatically more than the principal amount over the life of the loan, and this is how your lender gets paid. 

If you pay upfront to reduce your interest rate to, let’s say, 6%, your monthly payment goes down. 

Just two percentage points could save you thousands of dollars per year. Cha-ching!  Of course, you would need to come up with the buydown funds at closing or have a third party pay those funds on your behalf which could amount to thousands of dollars upfront. 

Pro tip: You can play around with your own numbers using a mortgage calculator to see just how a buydown might work in your situation. 

Don’t forget that those savings could be temporary, though, and likely will require either you or a third party to pay the buydown costs at closing. Remember how a buydown usually only lasts a couple of years and the buydown needs to be paid for at closing? That means you’ll see savings at the outset but, after that pre-determined amount of time, your interest rate may go up and the amount of closing costs at closing will definitely go up. 

Buydowns have the potential to save you some serious cash both on a monthly and over the life of the loan basis but will increase closing costs that either you or a third party needs to pay. It’s always important to triple-check your math and confirm with a mortgage professional. 

Types of Buydown  

When asking yourself, “What is a buydown ?”, the answer will depend. That’s because there are two main types of buydowns you may want to be aware of: 

The 3-2-1 Buydown

This can be the longer of the two buydown options. Basically, you’ll see lower payments for the first three years of your mortgage loan payments. Each year, your interest rate will go up by one percentage point. So, you’ll see your full interest rate in the fourth year of your mortgage loan repayment. 

It’s called a 3-2-1 buydown because you’ll receive a discount of three percentage points in the first year, two percentage points in the second year, and one percentage point in the third year. 

If your initial interest rate was 8%, the 3-2-1 buydown could look a little something like this:  

  • Year 1: 5% interest rate 
  • Year 2: 6% interest rate 
  • Year 3: 7% interest rate 
  • Year 4 and beyond: full 8% interest rate 

The 2-1 Buydown

A 2-1 buydown is basically the same but, as the name implies, only lasts the first two years of your mortgage loan repayment. Again, each year, your interest rate will go up by one percentage point. In a 2-1 buydown, though, you’ll see your full interest rate in year three of your mortgage loan repayment. 

If your initial interest rate was 8% it could look a little something like this:  

  • Year 1: 6% interest rate 
  • Year 2: 7% interest rate 
  • Year 3 and beyond: full 8% interest rate

There could also be a third, less common type of buydown: 

The Permanent Buydown 

A permanent buydown is just like it sounds: The borrower, or a third party on behalf of the borrower, pays the lender upfront at closing in exchange for a lower interest rate, permanently.  

There are a few reasons permanent buydowns aren’t particularly common:  

  • They can be prohibitively expensive. Of course, it costs a lot to drive down your interest rate for 15 or 30 years. That’s a big chunk of money your lender would be missing out on. 
  • You might not take full advantage. If you move or refinance before your mortgage loan term is up, you may have already paid for years of reduced interest that you’ll never actually see. 
  • Permanent buydowns are complicated. There’s a lot more math to consider when you’re talking 30 years versus 3. 
  • They may not be readily available. Lenders offering permanent buydowns may be few and far between. 

A smiling couple shaking hands with a mortgage broker.

Interested in a Buydown? 

So, could a buydown be right for you? They’re not for everyone, but they can help buyers who expect to increase their income over the coming years. 

If you’re interested, a home finance professional can offer great guidance. Whether you’re looking to drop your interest rate for a few years or the full loan term, be sure to speak with a mortgage professional before signing on the dotted line. 

Final Thoughts: What is a Mortgage Loan Buydown? 

Mortgage Loan Buydowns can be powerful tools. By reducing interest rates, homeownership could become a lot more accessible for many would-be buyers. 

So, if you have some extra cash lying around, or if you find a third party who would be willing to subsidize some of your costs, it can’t hurt to at least explore a buydown! And don’t worry. We’ll be there to support you every step of the way. 

* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.